Computing business profitability

Computing business profitability is important, as the profit of your business affects many vital considerations. For example, the amount of annual profit determines the amount your business must pay in taxes. Opportunities for business growth may depend upon how profitable your business is already, as may the level of financing for which your business qualifies. Many people confuse having good cash flow with being profitable. Just because a business has money coming in sufficient to meet its immediate financial demands doesn’t mean that it’s actually turning a profit.

A business is profitable if it brings in more money than it spends. It sounds simple, but computing business profitability can actually be quite complicated. There are actually two types of profitability, and they must be calculated separately. “Economic profit” is the increase in wealth from an investment, less the costs of the investment. “Accounting profit” is the difference between the retail sales price of the goods (or services) offered and the costs of acquisition of those goods (or in the case of services, the salaries paid to the persons providing the services and the other costs associated with service provision). Computing business profitability as a whole generally will mean computing the accounting profit, while economic profit is generally associated with the profit or loss connected to a particular venture of the business.

As long as your business keeps good accounting records, the actual calculations aren’t that difficult. Compare your current bank balance(s) with those at the beginning of the year – are they higher or lower now than then? Make the same comparison with your accounts payable, accounts receivable, and inventory balances. In general, you want to have lower accounts payable and inventory balances, and higher bank account and accounts receivable balances. If your accounts payable and inventory balances, combined, are higher than your combined bank account and accounts receivable balances, then you’re spending more than you’re bringing in – and not making a profit.

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